How Inflation Is Currently Measured?

There is a general saying in the business world, “What cannot be measured cannot be managed!” This is true of inflation as well. Hence, governments are supposed to constantly measure the amount of inflation in the economy. The idea is to have a control chart approach to keep inflation in check. This means that the government may expect inflation to remain at 3%, let’s say they decide the range is 2% to 4%. So now the government will take measures at regular intervals.

If the result falls within the range, no action will be taken. If the result is less than 2% or more than 4%, then immediate corrective action will be taken. Now, this may seem surprising but less than a certain amount of inflation is also considered dangerous in the present economic system. It is considered as the leading indicator of deflation, which must be avoided at all costs.

The argument we are trying to make in this article is that the current system of measuring inflation is not appropriate. Let’s understand how inflation is measured.

Representative Basket of Goods:

The first step in the process is to choose what is called the representative basket of goods. Now, this in itself is a problem for obvious reasons. There are many people out there belonging to different age, race, sex and income groups. Their consumption patterns are totally different from one another. Trying to find a basket of goods which are common to all the participants is a difficult process. The results arrived at are not validated by any scientific data. It is purely a judgment call made by the people collecting the data.

Prices Measured across Goods Periodically:

Now, once the goods are chosen, the next step is to keep a tab on the prices of these goods. Representative sample usually includes a few hundred goods and for each type of good there are several types of qualities available. Hence, measuring the change in prices becomes a very difficult exercise indeed.

Stage of Measuring Prices Needs To Be Chosen:

When we say that prices of goods need to be measured and recorded on a regular basis, we are making an incomplete statement. There is no single price of a good. The prices differ based on whether we are considering the prices at the manufacturer’s premises, the wholesaler’s premises, the retailer’s premises or the final price that the consumer has to pay for it. Each of these prices may also differ based on the geographical location, the nature of good and so on.

Hence, for the inflation survey to be effective, it must be clearly mentioned the stage and the terms based on which the data pertaining to prices needs to be collected and recorded.

Indexes Created Based On Assumed Usage:

Measuring inflation is largely an indexing exercise. Relevant weights have to be assigned to all the goods that have been included in the representative sample. These weights must be assigned based on the studies conducted which provide an estimate about the average income that a person spends on a given category of goods. Once again, this data is difficult to obtain and a big part of this exercise is based on the intuition of the person conducting it. The end result of this exercise is the price index which will be used to measure the changes in price levels.

Different Indexes for Different Classes:

In most countries, there will definitely be more than one price index. This is because the consumption patterns differ largely based on the age group as well as the extent of urbanization. Hence, different price indexes are created to track the extent of inflation amongst the different sections of the society.

The usual procedure for the governments is to keep on conducting surveys on a monthly basis. The interim data is reveled immediately and some policy decisions may be taken based on the data. Later, the detailed audited report is also presented for a detailed analysis of the findings of the report. Governments all over the world do spend a large amount of money and resources trying to obtain accurate data regarding inflation. The money is considered well spent since this data is supposed to form the basis of policy making. However, as we shall see in the next article, the whole process is riddled with flaws and collecting this data turns out to be a futile exercise instead.